13.2 Financial regulation in the uk

and for co-ordination between the Bank, the FSA and the Treasury in case of a nan-

cial crisis.

13.2.4The Financial Services Authority (fsa)

The FSMA set the FSA four objectives: market condence, consumer awareness,

consumer protection and ghting nancial crime. Each rm now obtains from the

FSA a single authorisation to carry out nancial business in the UK, with an associ-

ated list of permissions setting out what the FSA allows it to do. Under the previous

regulatory system, many rms had had a number of authorisations from different

regulatory bodies. Single compensation and ombudsman schemes (see Box 13.4) were

also developed and from the second half of 2001, all nancial rms became subject

to a single regime for tackling ‘market abuse’, a non-criminal offence that was added

to the already existing criminal offences of insider trading and market manipulation.

Three categories of market abuse were dened: misuse of information, giving false

or misleading impressions, and market distortion.

Box 13.4

The Financial Ombudsman Service

As well as setting up the FSA, the Financial Services and Markets Act 2000 established

a single nancial services ombudsman to help settle disputes between consumers and

nancial rms. This combined the work of four separate complaints procedures under

the previous regulatory system. The introduction of an ombudsman into a regulatory

system has two purposes – to increase public condence in nancial markets and thus

to encourage consumers to participate in these markets despite the manifest risks of

doing so; and to attempt to redress a perceived imbalance in nancial markets resulting

from consumer ignorance and asymmetric information.

The ombudsman can consider complaints about a wide range of nancial matters and

the service is free to consumers. The decisions of the ombudsman are binding on rms

but not on consumers. Consumers, having rst complained to the rm with which they

have a grievance, can take their cases to the ombudsman. If the decision there is not

to their liking, they retain the ability to go to court. The ombudsman does not, as the FSA

can do, either punish or ne rms for breaking rules.

The ombudsman service applies compulsorily to all rms regulated by the FSA for

certain types of complaints. In addition, rms not regulated by the FSA can volunteer to

participate in the service. Further, rms that are regulated by the FSA can volunteer to

have the ombudsman consider types of complaints that are not part of the ombudsman’s

compulsory jurisdiction. Through consultation, the Financial Ombudsman Service has

sought to widen the range of complaints with which it deals.

In the year ended 31 March 2005, 110,963 new cases were referred to the case-handling

teams. The number of new cases taken on by the ombudsman service has increased

rapidly each year from 25,000 in the year 1999–00. Unsurprisingly, the biggest area for

new cases was mortgage endowment cases (63 per cent of the total). The other gures

were: other investment-related cases 17 per cent; banking-related cases 9.5 per cent;

insurance-related cases 10.5 per cent.

377

....

FINM_C13.qxd 1/18/07 11:39 AM Page 378

Chapter 13 • The regulation of nancial markets

The FSA aims to maintain efcient, orderly and clean nancial markets and to help

retail consumers achieve a fair deal. However, the FSMA also requires the FSA to be

efcient and economic in its use of resources, requiring it to focus its efforts on what

it sees as the most signicant risks to the achievement of its statutory objectives, while

taking into account the principles of good regulation. Good regulation, according

to the FSA, should not seek to discourage appropriate risk-taking by regulated rms

or by investors. Risk, it accepts, is inherent in nancial markets and it is neither

practicable nor desirable to try to develop a regime in which no nancial rms fail.

Attempts to do so produce heavy-handed and expensive regulation that restricts

innovation and interferes with competition.

This leaves the FSA with a very ne line to walk and it has been criticised from

both directions – as being too large and bureaucratic, and as failing adequately to

observe and prevent developing risks facing consumers. Particular problems over which

the FSA has been criticised include split capital investment trusts (see Box 13.2),

Equitable Life, and endowment mortgages.

Equitable Life is the oldest insurance company in the world, having been estab-

lished as a mutual society in 1762. Until 1999, it had been regarded as a sound and

trustworthy organisation and was the country’s second largest insurance company.

At the beginning of 1999, however, it announced that it would be unable to meet

its commitments to its policyholders and launched court proceedings in order to

gain approval for cuts it proposed making in its payments to them.

In the 1950s, Equitable had started selling policies with a guaranteed annuity rate

(GAR) that allowed policyholders to opt for minimum pension payouts and a bonus

when their policies matured. The guaranteed rates were higher than average and were

very attractive. The GARs promised in the 1970s at a time of high ination came

to seem particularly high when ination rates fell in the 1980s and again in the

late 1990s. The society had realised the difculty by 1988 and stopped selling the

guaranteed policies. Nonetheless, it was committed to payments on the policies

issued before that date and at the beginning of 1999 it realised it would be unable

to meet its commitments of about £1.5bn.

It tried to renege on the guaranteed payouts in an attempt to maintain payments

to the majority of its customers who did not hold guarantees but, after several court

cases, the House of Lords nally ruled in July 2000 that Equitable had mistreated the

90,000 guaranteed policyholders. Equitable Life, still at this stage a mutual society,

sought a buyer who would inject funds into the company, but potential buyers were

put off by the society’s huge liabilities. In December 2000, it closed its doors to new

business. It announced that its with-prots policies would have no growth for the

rst half of 2000 and increased its penalty fee for withdrawing funds to 10 per cent.

At the same time, it tried to come to a compromise with its policyholders. It asked

guaranteed policyholders to drop their rights to future guarantees for a one-off

increase of 17.5 per cent in the value of their plans. Policyholders who did not have

guaranteed rates were offered a 2.5 per cent increase in the value of their policies in

return for signing away their rights to any legal claims.

Equitable Life also began to sell off some of its operations in order to raise cash

to pay its policyholders. Eventually, the Halifax Bank agreed to pay £1bn to buy the

378

....

FINM_C13.qxd 1/18/07 11:39 AM Page 379